Who do you think would win in a horse race, me or three time champion jockey Frankie Dettori?
Yeah, you’re probably right. Frankie Dettori could probably ride blindfolded and still win.
But what if I was riding a thoroughbred and Dettori a three legged mule?
I think I’d win hands down.
How is this all relevant?
Well, there are many three legged mules in retail at the moment and few thoroughbreds.
Let’s start with ASOS’s 40% plunge.
Firstly, let me strip away the headlines and the media spin. Debenhams, Next or Topshop would have killed for ASOS’s top-line growth.
If you’d have asked me a few years ago, I too would have applauded these results.
But revenue is vanity and profit is sanity.
ASOS has experienced somewhat of a collapse in so-called ‘EBIT’ margins from 4% to 2% and a 1.6% drop in gross margin. Factor in the tax paid on these earnings and I ponder how much actual cash is left for shareholders.
It really worries me that not so long ago investors were lining up to pay 60 times earnings for this stock. Alas, it’s easy to sit here now the stock has collapsed and to point fingers at others.
Now, I wouldn’t say ASOS is a mule, just a horse with terrible odds.
Call me crazy but I still think ASOS may have further to fall, especially if they don’t fix the margin problem.
Were I a shareholder, I would like to see management abandon the obsession with revenue growth and move to protect operating margins immediately.
With gross margin healthy, it appears business costs are out of control (processing all those returns maybe?)
Debenhams on the other hand is almost certainly a three legged mule.
Debenhams now boasts negative net margin of -8% in 2018 and a ballooning gap between current liabilities and current assets.
Most worryingly, the business is toast as it stands.
Locked in to constant discounting to try to liquidate stock to cash, customers circle Debenhams like vultures, waiting, knowing that further discounts will come.
Has anyone bought anything at Debenhams for full price over the past year?
Mike Ashley may well be the only man who can save the business.
Is there a future for High-Street retailers?
Long-term readers will know of my unwavering admiration for Simon Wolfson and his incredible management of Next.
Protecting margins and running the business in a prudent manner.
At the time of writing, Next trades at an earnings yield of 10%.
I have seldom bought a company at such a generous earnings yield and done badly, providing the balance sheet checks out that is.
In short, Next is a good horse with a great jockey. It’s also a horse that I expect to benefit from the decline of wafer-thin margin competitors.
Just take a look at Net Margins;
Looking into my crystal ball, I expect Next to announced it has performed in-line with expectations come the January trading update and investors who sold off the back of ASOS’s share price collapse will feel a bit silly for sharing.
Should this prove untrue, the following decline in the stock price will allow management to buy back shares at bargain basement prices with the hoards of free cash flow the company generates.
Investing in such a financially sound company that’s trading at such low valuations simply because the industry is struggling offers a great risk/reward proposition in my opinion.
Certainly I’m a big fan of Next at any price under 5,400p.
For what it’s worth, I also think that JD Sports Fashion looks interesting at these levels but I have not yet had a deep enough look into the company in order to be confident discussing it on here.
Do you own JD or Next?
Let me know what you think by commenting below.